Contrarian Investing
Prof. Gerlach
Sacred Heart University
Deborah J. Weir, CFAAuthor, TIMING THE MARKET (Wiley, 2005)
2
Fundamental Economics
As
Contrarian Investing
Because
Emotions Get In the Way
3
Background
• SEC Registered to sell hedge funds
• MBA in finance: NYU Stern School of Business
• Stamford CFA Society, Past President
• Deutsche Bank/Scudder: United Technologies, Rockwell, Mayo Clinic
• Instructor: NY Institute of Finance
4
We Will Forecast
GDP
Interest rates (up or down)
Direction of stock & bond markets
5
Economic ForecastingTools
1) Yield curve shape
2) Quality spreads
3) Central bank actions
6
Contrarian Tools?
• These tools are fundamental economic analysis
• People get caught up in emotion and overlook them
• It is always “different this time”
7
Ground your thinking in solid economic analysis to rise above hysteria.
Old adage, “Keep your head while all about you are losing theirs.”
New adage:
Make money when all about you are losing theirs.
8
1) Yield Curve ShapesPositive Slope (normal) Negative Slope (inverted)
http://stockcharts.com/freecharts/yieldcurve.html
9
Curve Reflects Investor Expectations for Future Rates
• Investors stay short if they expect rates to increase
• Investors go long if they expect rates to decrease
10
• Positive slope – increase risk: buy stocks, real estate, gold
• Negative slope – decrease risk: buy bonds or cash
• US Federal Reserve uses the shape of the yield curve to help forecast the economy
Asset Allocation Using Yield Curve Shapes
11
Normal Curve, Normal Growth: Nov. 2004
Equities
Inverted Curve, Recession:March 2007
Fixed-income or Cash
Steep Curve, Inflation:
July 2009
Gold, Foreign Currencies, Real Estate
Economic Forecasting Theory
12
Forecasting Practice
http://stockcharts.com/charts/YieldCurve.html
Click on the “animate” option to see how these two markets move:
The yield curve helps forecast the recent US investment cycle.
13
Inverted Curve 2006 Forecast the financial crisis of 2007 – 2009 and the decline of the S&P 500
Index.
http://stockcharts.com/charts/YieldCurve.html
14
Normal Curve 2009
http://stockcharts.com/charts/YieldCurve.html
Forecast strong stock market.
15
Steep Curve 2010(3mo./10yr. Spread > 300 bp)
http://stockcharts.com/charts/YieldCurve.html
Forecast inflation expectations.
16
Steep Curve 2009 - 2010
http://stockcharts.com/h-sc/ui
Inflation expectations weakened the US dollar.
17
Steep Curve 2009 - 2012Inflation expectations increased the price of gold
http://finance.yahoo.com/q?s=GLD
18
Steep Curve 2009 – 2011Inflation fears may end the decline in real estate.
http://www.dallasfed.org/microsites/research/econdata/housing-charts.pdf
19
Inverted Curve
Forecasts recessions
• Lower stock market
• Higher bond prices (& lower yields)
• Lower inflation
• Stronger currency
20
Ten-yr./Three-mo. Spread 1953–2012
http://www.clevelandfed.org/research/trends.cfm
21
Stocks Inverse of BondsCurve forecast stock market losses, bond market gains.
http://stockcharts.com/charts/historical/
S&P 500 Index
30-yr
Bond
Price
22
Federal Reserve Bank Uses the Yield Curve
http://www.clevelandfed.org/Research/Data/Yield_Curve/
23
This Site Has Monthly UpdatesOctober 26, 2012Covering September 26, 2012–October 26, 2012
Highlights October September
August3-month Treasury bill rate (percent) 0.10 0.11 0.10 10-year Treasury bond rate (percent) 1.79 1.81 1.76Yield curve slope (basis points) 169 170 166
Expected real GDP growth (percent) 0.6 0.6 0.6Old Formula: GDP = 1.87 + (.97 X spread)New Formula: GDP is weighted by the previous growth rates
Probability of recession in 1 year 8.2 8.1 8.5http://www.clevelandfed.org/Research/Data/Yield_Curve/
24
Applications to Global Economies
• BRIC
• PIIGS
• Managed economies limit the use but still can indicate the direction of growth
• 2011 indicators were negative
25
Outlook for the BRICshttp://www.economist.com/news/economic-and-financial-indicators/21567095-
trade-exchange-rates-budget-balances-and-interest-rates%20%20
Country 3-month 10-year BP SpreadBrazil 7.10% 9.57% +274Russia 7.66% 7.36% - 30India 8.18% 8.21% + 3China 3.80% 3.19% - 61
Given these spreads, what’s your forecast:
GDP
Interest rates (up or down)
Inflation
Currency
Direction of stock & bond markets
26
Outlook for PIIGS
Country 3-month 10-year BP Spread
*Portugal0.19% 7.89% +770
Italy 0.90% 4.84% +394
*Ireland 0.19% 4.58% +439
Greece 0.19% 16.08% +1589
Spain 0.19% 5.74% +555
http://www.economist.com/news/economic-and-financial-indicators/21567095-trade-exchange-rates-budget-balances-and-interest-rates%20%20
•No information for Portugal or Ireland in 2011
Given these spreads, what’s your forecast:GDPInterest rates (up or down)InflationCurrencyDirection of stock & bond markets
27
2) Quality spreads
• Forecasts trouble in emerging markets (1998 Russian bond default)
• Forecasts trouble in developed markets (1987 S&L crisis, 2008 crisis)
28
Merrill-Lynch High-yield
Index Constrained Less the Ten-year US Treasury Note:
(sometimes not available & no history)
http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html
29
http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html
Wall St. Journal Publishes High-yield Index
Nov. 2011
Nov. 2012 = 4.87%
30
Other SourcesFederal Reserve Bank of St. Louis (two-day lag)
Gives previous five days for easy comparison
http://research.stlouisfed.org/fred2/series/BAMLH0A0HYM2
31
You Can Get the Spread in Real Time
Good for trading options during the day…
High-yield ETF (JNK) – Ten-year yieldhttp://finance.yahoo.com/q?s=JNK&ql=0 http://finance.yahoo.com/q?s=%5ETNX
32
Is This Stock Market Recovery Sustainable?
S&P October 1 - Nov. 23, 2012
1340
13601380
14001420
14401460
1480
10/1
/201
2
10/8
/201
2
10/1
5/20
12
10/2
2/20
12
10/2
9/20
12
11/5
/201
2
11/1
2/20
12
11/1
9/20
12
S&P
•Fiscal Cliff
•Greek Default
•Global Slowdown
33
Bull Market Confirmed by Quality Spreads
Merrill-Lynch High Yield Less the Ten Year Note
Quality Spread Oct. 1 - Nov. 23, 2012
3.84
4.24.44.64.8
55.25.4
10/1
/201
2
10/8
/201
2
10/1
5/20
12
10/2
2/20
12
10/2
9/20
12
11/5
/201
2
11/1
2/20
12
11/1
9/20
12
%
34
3) Central Bank Actions
• Open Market Operations
• Money Supply
35
Federal Reserve Open Market Operations
• Normal repurchase agreements = $3.25 billion daily prior to 9/11
• September 11, 2001 = $35 billionhttp://www.ny.frb.org/markets/omo/dmm/temp.cfm
What is the Fed doing today? Tightening? Easing?
36
Federal Reserve Controls Money Supply and the Shape of the Yield Curve
http://www.dallasfed.org/assets/documents/research/econdata/us-charts.pdf
Financial Crisis
Market Turn
QE2
QE3Turn
Turn?
37
Global Economic ForecastingTools
1) Yield curve shape
2) Quality spreads
3) Central bank actions
38
Fixed-income Is a Good Data Set for Forecasting Economies and Markets
Large Data Set (Eight Times the Volume of Equities)
Depicts Investors’ Actions Rather Than Opinions
Forward-looking; No Reliance on Historical Financial Statements
Low Turnover and Transactions Costs
Government influence on the shape of the yield curve works for you; not fighting City Hall
39
UpdatesBlog:http://timingthemarket.blogspot.com/
Twitter.com: @debweir
Voices of New York Institute of Finance Faculty: http://www.nyif.com/blog.html
Email [email protected]
Contrarian Investing
Prof. Gerlach
Sacred Heart University
Deborah J. Weir, CFAAuthor, TIMING THE MARKET (Wiley, 2005)